Dear Tax Talk:
If I receive a settlement payment from an insurance company due to a workers' compensation claim, is that type of income taxable either on a state or federal level? Or is that income considered "not earned" and therefore not taxable? The settlement looks to be in excess of $100,000.

Thank you.
-- Tracie

Dear Tracie,
If you're injured at work, the tax law gives you a break. Workers' compensation benefits are intended to replace lost wages. Wages, of course, are taxable income. However, the workers' compensation is also intended to compensate you for injury, and payments for physical injuries are not taxable.

Amounts you receive as workers' compensation for an occupational sickness or injury are fully exempt from tax if they are paid under a workers' compensation act or a statute in the nature of a workers' compensation act.

The exemption, however, does not apply to retirement plan benefits you receive based on your age, length of service or prior contributions to the plan, even if you retired because of an occupational sickness or injury. If you return to work after qualifying for workers' compensation, salary payments you receive for performing light duties are taxable as wages.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

To ask a question on Tax Talk, go to the "Ask the Experts" page, and select "taxes" as the topic.